Income Protection Insurance Explained.

In today's blog we're having a look at income protection and to make it easier, I've broken this down into five key sections for you. 

1. We're going to have a look at income protection 101 or the basics. 
2. We're going to have a look at the key features of the income protection policies that you need to know. 
3. We're going to take a look at claims and the sorts of things that you can receive payments from these policies. 
4. We're going to have a look at how much this costs and the factors that go into pricing. 
5. We're going to have a look at super versus non-super and which is the best structure for you to have this income protection. 

 Income Protection Insurance Explained.

Hi folks, welcome back to the blog and I share blog that help simplify the world of insurance to make it easier for you. Each time I release a new blog. One of the four insurances that I deal with is income protection, which is what we're going to be focusing on today. 

The idea of this blog is to provide you with a complete guide and help you with the understanding of income protection. Whether you've got a policy in place at the moment or you're looking into income protection to work out whether or not it's right for you at the moment.

So let's get started with section number one, which we'll have a look at the basics. You may have heard people say that income protection is really important because your ability to earn an income is your biggest asset. What they mean by this is that if you were to add up all of your future income between now and retirement, it's a massive number.

 

As an example, let's say that you're 40 and you're earning a hundred thousand dollars a year. I've assumed that this income grows at 2% each year. The amount of income that you'll earn between now and retirement is $3.2M. Income protection provides a safety net for this future income if you're unable to work due to injury or illness. 

Unlike some of the other insurances, there's no specific injury or illnesses that are listed on an income protection policy that leads to you being able to claim. The easiest way to think about income protection I find is that you're covered for anything that you'd be able to maintain a doctor's certificate for. One of the most common questions I get asked about income protection is, am I covered if I lose my job or redundancy? 

Redundancy is not covered in an income protection policy. There are a few policies in the market that do cover redundancy, but if you take the time to look into them, in my opinion, they're not worth the

paper they're written on. Some policies will have temporary features that you can exercise if you have lost your job or been made redundant, but in my opinion, covering these short term gaps in your income is not what income protection is designed to do. 

The best way to protect yourself from this in my opinion is to work on maintaining a cash buffer to get you through these short term periods without income. Now if you were to claim the benefits that you receive from your income protection policy are taxable and the premiums themselves are eligible for a tax deduction and I'll touch on a bit more of this later in the blog depending on whether you have this through super or non-super.

Now let's jump into the key features. There's the monthly benefit, there's the waiting period and there's the benefit period. Now the monthly benefit is how much you will be paid if you need to claim on your policy. An important thing to note about this monthly benefit is the amount that's listed on your policy is before tax and if you do go on an income protection claim, the money that you receive will also have tax deducted from it.

 

If you'd like to work out how much tax you'll pay, there's a link to a calculator that you could throw in that monthly benefit amount and it will work out the tax based on the tax year and show you how much income you'll receive net if you were to go on claim the maximum monthly benefit varies a little bit depending on which provider you go with, but generally speaking you can insure up to 75% of your income. 

The reason for this is that the insurance companies want to leave some motivation for you to go back to work if you were to be on claim. One thing that I always consider when I'm looking at how much to insure is adding super annuation contributions to this monthly benefit. 

What this does is that in addition to those regular monthly amounts that you receive, it will provide an amount for super. These additional payments will cover your future super payments and this is really important because if you were to go and claim now and you didn't have this feature, then your account balance at retirement in super would be the same as it is now plus or minus earnings over the journey.

This can make a massive difference to what your future balance would like and the amount of money you have to spend in your retirement. The next key feature we'll look at is the waiting period and the waiting period is how long you need to be off work before you start to get paid from the insurance company. The waiting period is something that you can choose based on your circumstances and can be anywhere from two weeks right through to two years. 

The waiting period has a massive impact on price with the shorter the waiting period, the more expensive the cost for the cover. To give you an idea of the difference in premiums between a 30 day wait and a 90 day wait is about 40% another important thing to note about the waiting period is that the first payment that you receive will be the month after the end of your waiting period. 

To give you an example, if you had a 30 day wait, the first payment wouldn't happen until the 60th day and if you had a 90 day wait on your policy, the first payment wouldn't be made until 120 days when you are considering which waiting period would work best for you. Make sure you have enough sick leave, holiday pay and cash savings to make sure that you can get through this time between when you stop working and when the insurance company would start to pay. 

Finally, the benefit period as the name suggests is how long the benefits on the policy would be paid for. Benefit periods can be anything from two years with some providers paying benefits through to the age of 70 you can again choose which option works best for you. The longer the benefit period, the more expensive the premiums would be.

Now I wanted to talk to you about another couple of key features that you might see on your policy and these refer to the different types of contracts that you might have. 

These two types of contracts are known as an agreed value policy and an indemnity contract. The major difference between these two is when you are required to prove your income within an agreed value policy, you're required to prove your income when you apply. 

Whereas an indemnity contract, you're required to prove what your income is when you claim. Now, different providers will have different rules where it comes to the period before you claim to prove your income for an indemnity contract. So make sure you check with your provider. If you already have income protection in place, I'd suggest checking with your policy to say which of these two types of contracts you have. 

If you're looking at income protection now there's only one way to buy these policies which is an indemnity contract as of the 31st of March, 2020 these are great value policies are no longer being sold. so let's move on to claims and look at the sorts of things that you can claim on. As I mentioned before, unlike some of the other insurances such as trauma insurance, which is really specific about the things that you can claim on, there are no listed injuries or illnesses for a successful claim when it comes to income protection. 

To give you some insight into the sorts of things that you can claim on. I wanted to share with you the claims statistics from one of the major insurers. This will give you an indication as to the actual figures that they paid out in a year. As you can see, about 30% of all claims are paid out in the year.

Were mental health related such as anxiety, depression and stress. 

Next up is musculoskeletal, which is your back and your neck and this accounted for about 14% of all claims in the year. Third on the list which was accidents, again, accounting for about 14% of all claims and coming in fourth was cancer related illnesses which accounted for about 12% of the claims that were paid out in the year for income protection. 

As you can see from the above four broad categories, these all accounted for about 70% of all of the claims paid for income protection in the year. Now, whilst these numbers are from one insurance company, they are pretty reflective of what happens in the market. As I mentioned before, the easiest way to think about income protection is you'll be paid for anything that you'll have a doctor's certificate

for stating that you can't work this doctor's certificate. 

We'll need to see you unable to work for longer than whatever waiting period you've selected on your policy. Depending on your policy and how this has been set up, there are some extra features that you can claim on. If your policy is owned and paid for personally, I. E. Outside of super, the most common extra that I say paid is what they call the specific injury benefit and this pays out a set amount of money irrespective of whether you can continue to work or not. 

The reason I'm sharing this with you is that I've personally had three of these specific injury benefits paid to me and to give you an idea, I've helped two of my clients with these claims in the last month alone. Okay, so let's jump in and see how much this costs given. There's so many factors that

go into determining the price. 

It's really difficult to give a guide here. Some of these factors include age. With the older we are, the more expensive the premiums occupation with the more risky our occupation, the more expensive the premiums, lifestyle factors such as smoking and what we do outside of work. So jujitsu, rock climbing, those sorts of things would obviously be more risky. Gender, the difference between male and female also affects the cost of these premiums. 

The waiting period and the benefit period that you choose will have a factor on these prices and of course one of the major factors is how much you earn to get some quotes for this. You can either go back to your existing super fund who all tend to have an online premium calculator or you could try an online service such as Life broker who will compare the pricing from about five different providers. Just a heads up that Life broker.

It is owned by TAL who's one of the big life insurance companies. The other thing that affects price is whether you choose to have stepped or level premiums. I do believe that income protection is one of those covers that for the right people level premiums work, but again, this is a case by case proposal. As I mentioned earlier, the premiums that you pay for income protection are tax deductible. You can claim this personally in your tax return.

 

If you pay for these premiums from your bank account or the tax credit is passed on directly to you. If you pay these premiums directly from your super to explain this, let's assume that your premium from super was $2,000 you receive a tax credit of 15% to pay these premiums and what will happen is that the insurance company will charge you that net amount of $1,700 per year for those premiums. 

In this scenario, if you're paying for your premiums from your super, you can't claim anything for these premiums in your personal return. So should you have this through your super or non-super. There are obviously pros and cons for both setups. I'm going to keep these differences simple so that we don't get too confused. 

Income protection policies that are owned and paid for outside of super generally have more of those extras included in the policy. For example, the specific injury benefit that I mentioned earlier in the blog is one of those extras that you could have as part of your policy if owned and paid for outside of super. This would not, however, be covered if you had your policy owned through super. The reason for this is that when you have a policy that's owned and paid for through super, you must satisfy the rules of the super world to be eligible to claim on those benefits.

The technical name for this is that you must satisfy a condition of release. The major reason I see people do their income protection through super is cashflow. We don't tend to treat the premiums that are paid for from super the same way we would as if we had to fund those out of our own cashflow. If you do elect to pay these premiums through your super, while you won't feel this initial pain in your hip pocket, it does affect your long term wealth. 

Here's another example. Let's say you were 40 and you had a super balance of about 200 grand and were earning a hundred thousand dollars every year. Let's also assume for this scenario that your income protection premiums were about $3,000 a year and you decided to pay for these from your super fund.

As you can see in this example, the difference between your balance with and without the premiums coming from super is about an $85,000 difference. There are strategies that you can do to negate this difference, but most people who set up their insurances through super don't give this much thought. The reason I wanted to highlight this was that you're essentially just robbing from future you to pay for current you. 

If you are tossing up between the two, it's important to consider the long term wealth implications of this rather than just the initial cashflow impact.